Yes, I am talking about the dreaded debt deflation (in Irving Fisher’s sense) in China.
It works like this, more or less: Banks create money by extending credit; when banks lend you money, your deposit account balance increases. That money created by bank’s extending credit is included in the money supply calculation. Increasing debts in the economy means increasing money supply, more or less, and that funds economic growth and, of course, asset prices.
It all goes well when asset prices keep rising because the debt level looks lower. It is when things go into reverse that what looked like a comfortable debt level suddenly appears to be problematic. With over-investment in various sectors in the Chinese economy and over-capacity at a point where many companies are not profitable, as well as a real estate bubble that is in the process of bursting, the level of debt is becoming a burden.
Recent statistics show that China’s money supply growth is slowing, loan growth is mediocre, and, occasionally, banks’ deposits are dropping. The conventional explanation for deposits falling is that money is going elsewhere: perhaps real estate, or perhaps the stock market, and more recently, wealth management products which offer better yields, for example. Most reason then that if deposits are leaving, banks can’t extend as much credit as they want to.
However, there is another possibility.
With the economy slowing and companies not profitable, demand for credit is slowing. Not surprisingly, with the real estate bubble bursting, demand for mortgages is also slowing. With demand for credit lower, the banking system is creating money at a slower pace. And with asset prices falling, it is be possible (in the future, if it is not already happening) that loan repayments and defaults overtake new loan creation. In that event, the banking system is destroying money, all else being equal (i.e. if the central bank isn’t doing anything).
Loan growth is now slow as demand is low, and deposits fall every few months. At the same time, M2 money supply growth dropped on the month. You can argue that some of the money has gone to somewhere that has no way to be included in the money supply numbers, however, there is also the possibility that debt deflation, if not already started, is approaching.